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“Robust demand, industry wide cost pressures and
persistent supply side constraints continued to support the fundamentals for the majority of BHP Billiton’s core commodities. In that context, another strong year of growth in Chinese crude steel production ensured steelmaking material prices were the major contributing factor to the US$17.2 billion price related increase in Underlying EBIT.

However, BHP Billiton has regularly highlighted its belief that costs tend to lag the commodity price cycle as consumable, labour and contractor costs are broadly correlated with the mining industry’s level of activity. In the current environment, tight labour and raw material markets are presenting a challenge for all operators, and BHP Billiton is not immune from that trend. The devaluation of the US dollar and inflation reduced Underlying EBIT by a further US$3.2 billion.”

BHP Billiton, which uses a fiscal year ending June 31st, reported record full year EBIT of $32bln on revenues of $72bln.

The 62% year on year increase in EBIT was mainly caused by ‘uncontrollable’ price increases. BHP managed to increase volumes slightly, but this gain was offset by higher costs of over $1.4bln. In a breakdown of the cost increase BHP estimates approx. half of the increase to be structural.

Implications:

Analysts point at the weakness of BHP’s buy-back program, in which the company runs the risk of overpaying for its own shares. In general the buyback and dividend program reveals the lack of investment options and the hesitance of management to embark on aggressive expansion in the light of global economic and financial uncertainty. Though industry leaders continue to mention supply shortage as key industry driver, they don’t want to end up at the top of the cost curve.

Key developments to watch in the coming months are the continuation of China’s rapid growth; high iron ore, copper & coal prices; and survival of the international financial system. If any of these trends turn around, 2011 might well be the peak of the mining industry’s profits, after which the mantra of ‘cost control’ replaces the current theme of ‘capacity growth’.

“Chilean miner Antofagasta PLC on Tuesday doubled its interim dividend after reporting a 54% rise in first-half net profit due to higher average commodity prices and volumes. Chief Executive Marcelo Awad said the miner remains well positioned to deal with commodity-price volatility and relatively strong cost pressures given its low average net-cost position. …

Antofagasta expects global copper output to fall 500,000 tons short of demand this year and forecasts prices to average more than $4.20 a pound in the second half. This compares with $4 a pound in mid-August and a record average $4.26 a pound for a calendar half-year in the first half. Antofagasta reported an 84% rise in first-half earnings before interest, taxes, depreciation and amortization, or Ebitda, to $1.95 billion. Net profit rose 54% from a year earlier to $696.2 million, while the declared interim dividend rose to $0.08 a share from $0.04 a share in the same period a year ago.”

Antofagasta mainly operates in Chile. The key growth project is the ‘Esperanza’ project close to the operating ‘El Tesoro’ mine. Exploration in Peru, USA, Australia and Pakistan signals the ambition to expand internationally.

The company is controlled by the Luksic family, which holds approx. 65% of the shares.

Implications:

Antofagasta appears not to be affected by the strikes that stopped production in other mines in the region, signalling a good relationship of the management with the unions.

The payout ratio of 11% of profits is above expectations, but below the 35% benchmark the company adheres to. The management is either hoarding cash for a significant investment or is planning to announce a special dividend at the end of the year. Last year a special dividend of 100% was turned out at year end.

“Newcrest Mining Ltd., the world’s third-largest gold miner by market value, said Monday its fiscal full-year net profit rose 63% to 908 million Australian dollars ($940.1 million), as production jumped on its acquisition of Lihir Gold Ltd. and the price of gold soared.

‘The world economic and political issues are supporting a very strong gold price going forward,’ Chief Executive Greg Robinson said in a conference call. He didn’t provide a specific price forecast. The surging gold price, which averaged A$1,409 per troy ounce over the company’s fourth quarter ended June 30 and has since hit successive records up to $1,814.89 per ounce, helped lift earnings at the Melbourne-based company from A$556.9 million the previous year.

On the underlying basis preferred by equity analysts, which excludes one-off and accounting items, net profit came to A$1.06 billion in the financial year, the company said in preliminary annual results. Analysts had suggested an average figure of A$1.05 billion.”

Newcrest is the world’s 6th-largest producer of gold, producing approx. 2.5bln ounces in 2010. About a quarter of the production comes from Western Australia’s Telfer mine.

A 43% increase in production volume results in 76% higher employee salaries and 87% higher maintenance and contract labour, showing the cost pressures that have led to the current $513/oz production costs.

Implications:

Newcrest is working on the integration of Lihir, bought a year ago for $8bln. The lower grade deposits the company is developing change the cost structure of the company and reduce its historically high profit margin. As a result the company will become more similar to large rivals Barrick and Newmont.

High gold prices drive gold miners to pay out large dividends, trying to convince investors of the benefits of holding gold miner shares rather than gold ETFs.

“Rio Tinto’s iron-ore-driven profits set company records for the interim period but shares fell for a fourth day as investors’ flight from equities hits resources stocks hardest.

Tom Albanese, chief executive of the mining company, commented on the widening gap between miners’ rising earnings momentum and falling share prices. ‘There is a distorted set of economic drivers associated with the current uncertainties with respect to us and the European debt markets,’ he told the Financial Times. ‘You have an exaggerated diversion of ‘risk on’ to ‘risk off’ trades. It is difficult to come to any conclusions, but this is a backdrop that could persist for some time.’

… sector-wide pressures of rising costs and adverse exchange rates weighed on Rio’s profitability, contributing to earnings that missed consensus expectations. Higher costs for energy, materials and equipment lowered Rio’s underlying earnings by $479m, and exchange rates between the weak US dollar and strong Australian and Canadian dollars – currencies in which it incurs costs – reduced them by a further $810m in the first half.”

Total increase of earnings because of price increases ($5bln) was offset by almost $3bln lower earnings because of volumes, costs and exchange rates.

Just as Anglo American, the company gives a detailed explanation of the rising costs, providing rare details on the waiting times for various types of equipment (see outlook – page 8). The outlook shows the average delivery time for equipment currently is approx. 6-9 months higher than average.

The impact of lost volumes because of weather impact (hurricanes & floods) in the first half of the year, often mentioned as important driver of prices, is only $245mln.

Implications:

Rio Tinto does not appear to be concerned with the current importance of iron ore as the driver of earnings. The company regards construction industry growth in China the most important metric for the economic outlook and mentions expansion of production capacity of Western Australian iron ore mines as key development priority. The company joins competitor Vale in this single-minded focus, while BHP Billiton appears to be more committed to diversify, as signalled by its acquisitions in the shale gas industry.

The presented $26bln capex package does not yet include projects in advanced feasibility stage such as Simandou (iron ore in Guinea). The relatively conservative dividend and buy-back program does leave room for very aggressive development spending and helps the company to keep a very low gearing. So far all major miners choose to keep the gearing low despite their positive commodities market forecasts.

“Anglo American has taken advantage of booming commodities prices to boost its interim pre-tax profits by more than two-thirds. A flight to safety among nervous investors has driven up prices for precious metals and diamonds, buoying first-half revenues by more than a fifth at the FTSE 100 miner and prompting Anglo to increase its dividend by 12 per cent.

Strong demand in China has also pushed up prices for iron ore and copper, helping Anglo shrug off the weak US dollar and harsh weather conditions in South Africa and Australia, which included the extensive flooding in Queensland earlier this year.

Anglo has an investment pipeline of $66bn to develop its iron ore and copper mines in South America and coal projects in Australia in order to reap the rewards of booming commodity prices.”

Good financial performance was offset by very poor safety performance: the group recorder 10 fatalities in the last 6 months (8 in the platinum business).

$450mln of the revenues (11%) are achieved in De Beers’ diamond business. Iron ore & Manganese (26%) and Platinum (23%) account for the largest share of Anglo’s revenues. Iron ore & Manganese (29%) and Copper (28%) bring in the largest part of the earnings, driven by particularly high commodity prices.

Implications:

Focus of Anglo American’s presentation was on expanding production (capex of $2.3bln for 2011H1 with pipeline of $66bln) and on cost control. The company’s operating profit compared to the same period last year suffered from $500mln higher cash costs. Input cost pressures were explained in detail in the investor presentation (see below) For each product the management presented initiatives for cost reduction.

Iron ore volumes (-12%) and metallurgical coal volumes (-19%) were down compared to the same period in the previous year, caused by weather disruptions that put BHP Billiton and Rio Tinto in the same position. It will be interesting to see the method of reporting the volumes next year if production can go on without interruptions. Higher volumes will then most likely be presented as significant achievements, without any mention of the disruptions of this year.

“Russian coal and steel group OAO Mechel’s mining division, Mechel Mining, plans to hold an initial public offering in London this year, two bankers familiar with the matter said. The deal may raise between $3 billion and $4 billion, the first banker said adding the placement will most likely take place in the fourth quarter.

Morgan Stanley will take the lead roles on the deal, the bankers said. ‘It’s one of half a dozen Russian deals due out of the blocks in the fall,’ the first banker said. A handful of Russian deals were withdrawn from marketing in London in the first half of the year, after investors pushed back on price and amid volatile markets.”

Mechel announced the intention to bring the Mining division to the stock exchange in November 2010, still doubting between London, New York, and Hong Kong. The company itself listed at the end of 2004 in New York.

Based on a new share offering of 25% of common shares the size of the IPO still will be in the range of $3.3-4.0bln, above earlier expectations.

Implications:

The proceeds of the IPO will help Mechel to expand production capacity by developing the Elgo coal deposit and to reduce its gearing. Like many Russian companies Mechel is facing high debt costs while and at the same time needs to invest heavily. This combination of issues drives many Russian companies to an IPO this year.

“Freeport McMoran, the world’s biggest publicly traded copper producer, has predicted strong markets that could push its cash flow as high as $9bn this year compared with $6.3bn in 2010. The financial strength of Freeport, which declared a special dividend last year to clear excess cash, reflected even higher demand for copper and gold this year than last.

Richard Adkerson, Freeport’s chief executive, said destocking of copper inventories in China was helping to support the copper price. He noted China’s efforts to cool the economy but said: ‘There is a tremendous amount of spending on infrastructure and housing. China has the financial resources to continue to invest in the face of global economic conditions.’”

Freeport says it is spending money as aggressively as possible to expand (planning to spend $2.6bln on capex this year), but still this year’s gold production is forecasted to be lower than last year’s output while copper output is increasing marginally.

Mr. Adkerson mentions rising input costs, caused by high demand, as the key issue the industry will face over the coming years.

Implications:

The industry is facing rising input costs for fuel, power, labour & equipment while average grades of many flagship operations are falling. As a result both mining and processing costs per unit of product increase rapidly, supporting high commodity prices.

Mining contractors and equipment manufacturers are faring well as mining companies face resource shortages (Caterpillar announced a 44% increase in profits this week). Miners are forced to pay high prices and book equipment and contracted services months in advance because of global shortages.